Investor pessimism and anxiety may be overdone?

In recent weeks stock prices have pulled back about 5% from their highs – well within the normal range of a normal correction (8-11%).  However, in the midst of the upcoming and extraordinary election, weakness in anything from economic data to stock prices will put investors on edge.  Given the upcoming “big” event we thought we would share a few thoughts with you in terms of financial markets.

First and foremost, it is important that investors remind themselves that stock and bond markets are essentially driven by corporate earnings and Federal Reserve (“The Fed”) policy.  Though politics plays an important role in governance of this great nation and on the global stage, it has less of an effect on stock prices – particularly in the first few months of an administration.  We have no doubt that markets may be more volatile than normal next week, however our research and the history of politics and markets suggest that once the votes are tallied, stock and bond markets will go back to their business of focusing on their primary drivers – profits and the Fed.

Could one of the potential candidates eventually change important parts of the economy for better or worse? Yes.  Can they do so quickly? No.  In the case of the two candidates of choice, we know a lot of what the Clinton administration will bring – “business as usual.”  However, we know little detail of what the Trump administration would bring and, though mysteries make for great novels, we would be careful about letting this one create the feeling of “abandon ship!”   After all this is a democracy – thankfully – and it will take a lot of time and practical men and women on The Hill to make any changes, let alone drastic ones.  So after the dust settles next week, our view is that markets will refocus on what is important – corporate profits and Fed policy – and in that light we see more positive than negative for investors.

After a corporate profits recession that lasted more than a year, we are seeing a turn for the better across some of the most important sectors and industries that drive longer term economic growth. This includes technology, materials, industrial and energy companies.  As these sectors continue to recover, this can easily drive economic growth rates and support higher stock prices.  Interestingly, it is in these areas of the market where stock prices represent great value relative to profitability, hence our optimistic view.

There is little doubt, given an earnings and profit recovery, that the Fed will raise rates as we move forward.  Be not afraid of The Fed!  Rate hikes will come with lots of language that will support higher stock prices such as, “given the strong earnings and economic outlook we feel it is prudent to raise rates.”  Historically, initial Fed rate hikes combined with this type of language has been “music to the market’s ears” and can drive stocks higher quickly.  You won’t want to miss it, but unfortunately you will have to wait for it, which includes getting through next week!  So far we have had a normal market pullback. If markets decline another 5-6% it would still be within normal range and create an excellent stage for a big rally through year end.

As you know, we have a very flexible approach to our work and should our analysis of this current environment prove incorrect, we are prepared to become more defensive through your asset allocation, sector management and the use of carefully placed stop loss orders.

In the meantime, let’s get out there and vote to make a difference!

If you have any questions or thoughts or have experienced any significant changes in your financial circumstances please let us know.  Thanks again from all of us for your continued vote of confidence.

Your Team at Main Street Research